Week of August 22nd

Key Points for the Week

• Stocks struggled last week based upon hawkish Fed comments. The market awaits the Jackson Hole summit this week.
• More than 90% of S&P 500 companies have recently topped their 50-day moving averages. Historically, this has led to continued strong performance.
• The S&P 500 has recovered half of its 23.6% bear market drop.

Upcoming Changes to the College Financial Aid Formula

The Free Application for Federal Student Aid (FAFSA) is a form completed by current and prospective college students to determine their eligibility for student financial aid. In addition, states and colleges use FAFSA information to award their own grants, scholarships, and loans. But, since aid is limited, you have to meet the deadlines. For federal student aid for the 2022-2023 academic year, the FAFSA form must be submitted by June 30, 2023. Each state has its own deadline which is earlier, and each college may have its own deadline. To find these deadlines, click here.

If you currently have a child in college, or one that will be going to college in the near future, you can learn about the upcoming changes to the college financial aid formula here. If you have any questions about these changes, or how saving for college fits within the scope of your financial plan, please contact us.

Economic Update

Investment professionals are in the middle of a heated debate. Since mid-June, United States stock markets have moved higher, regaining about $7 trillion as many investors who had sold shares during the first half of the year began buying again, reported Lu Wang of Bloomberg. The debate is about whether the stock market is in the midst of a bear market rally or a new bull market.

A bull market occurs when share prices rise steadily over time.

From a fundamental perspective, the bears expect that inflation will remain elevated, forcing the Fed to raise interest rates much higher, causing a severe recession. The bulls, like us, believe that inflation might have peaked in June and that the Fed is likely to pause for a while following one more rate hike of [0.50 to 0.75 percent] in late September. The bears see lots more downside for earnings and valuation multiples. We see flattening corporate earnings through the end of this year and believe that forward valuation multiples bottomed on June 16. In our bullish narrative, the market could move sideways for a while before moving to new record highs next year.

Edward Yardeni, Yardeni Research

Morgan Stanley has repeatedly argued that the recent stock market rally is nothing but a bear market trap, while Bank of America has warned that stocks have more room to fall based on historical trends.

Will Daniel, Fortune

In an effort to determine whether it is possible to distinguish bull markets from bear market rallies, one Minnesota research group examined data going back 65 years, reported Bloomberg. “The answer is that it remains next to impossible to say in real time which ones will last. Methods people claim work often fall apart when looked at rigorously.”

Last week, a pause in the rally added fuel to the debate. The Standard & Poor’s 500 Index declined after four weeks of gains, reported Ben Levisohn of Barron’s. U.S. Treasury yields moved higher as investors parsed Federal Reserve commentary, reported Samantha Subin and Natasha Turak of CNBC.

In our opinion, the stock market will remain volatile, without a clear direction, until after the election.

This Week in the Markets

As the Federal Reserve prepares to kick off its major monetary policy conference in Jackson Hole, Wyoming, its tone has become more hawkish. That is pressuring markets, which have rallied in recent weeks as inflation has dipped lower and other economic data has remained healthy. The market’s rally suggested the Fed’s approach was working and investors began to expect rate increases may slow. However, those expectations were checked by the Fed’s comments last Thursday that additional rate hikes will be needed to get inflation under control.

The market rally also improved market breadth. More than 90% of S&P 500 companies have recently moved above their average price over the previous 50 days. This measure tracks the percentage of stocks that are trending upward, and a high percentage typically means continued outperformance. There have only been 14 other periods when 90% of the S&P 500 has been above its 50-day moving average. Only once did the S&P 500 decline in the following 12 months, and the average return during those periods was 17.3%.

Economic data reported last week was fairly strong. Industrial production surged 0.6% to a new record high. Strength in auto production and energy pushed the measure higher. Production is far stronger than in past recessions. Core retail sales, which exclude food and energy, rose 0.7% — or 0.1% when adjusted for inflation. That small gain was the first, after adjusting for inflation, in three months.

The S&P 500 and global MSCI ACWI both dropped last week, while the Bloomberg U.S. Aggregate Bond Index gained slightly. Comments from the monetary policy conference at Jackson Hole and PCE inflation will lead a list of key economic releases this week.

Macroeconomic Indicators

Last week, two important macroeconomic indicators pointed toward an economy that may avoid a recession and clearly isn’t in one now. The big surprise was industrial production, which is one of six indicators considered by the National Bureau of Economic Research to declare a recession.

Industrial production rose 0.6% in July, hitting a new record high. This is a volume-based index, and that means it’s adjusted for inflation. Current levels of industrial production are above those of past recessions. Even if we assume that economic activity peaked in March, industrial production is running more than 1% higher than March levels.

The report provided more good news. Rising industrial production was mostly driven by the auto manufacturing sector, which has struggled to increase production over the last two years amid a semiconductor shortage. But production rose almost 7% in July and output is now higher than pre-pandemic levels. The rising supply of new vehicles should also help ease inflation in the auto sector.

Oil and gas drilling activity was another positive from the report. Output in this industry rose more than 3% in July and is up a whopping 55% over the past year. Rising oil and gas drilling output is welcome news on the inflation front, as energy prices have accounted for almost 30% of inflation over the past year (using the CPI index).

The other data point was U.S. retail sales. Overall sales were flat in July, but that was partly impacted by lower gas prices. Core retail sales (excluding autos, gasoline purchases, and restaurant sales) surged by 0.7%. Combine that with upward revisions to May and June retail sales, and we’re looking at relatively strong consumer spending on goods. Even if we adjust for inflation, i.e., by looking at “real” retail sales, spending was still up 0.1% in July, the first increase in three months. What is striking is how strong real retail sales are more than two years into the pandemic, which is when we got the big shift from services to goods consumption. It was widely anticipated that sales would fall back to trend by now as consumers switch back to services. But real sales are running 10% above the pre-crisis trend as of July.

The housing sector countered these positive reports. Existing home sales fell 5.9% in July and are now 20% lower than a year ago. The drop in demand is impacting builders as well, with housing starts shrinking 9.6% in July. No surprise that the decline was led by single-family starts, which fell 10.1% and are well below where they were before the pandemic in February 2020.

Housing has historically led recessions, and a significant reason is housing activity falls as the Federal Reserve increases rates, which pushes up mortgage rates. Yet, there are a couple of important differences between now and what we’ve seen in the past. For one thing the quality of borrowers has been much higher in this cycle, as lenders maintained tight standards following the last housing crash. Most recent mortgage originations have been going to borrowers with credit scores over 760. Also, prior to the recent rate hikes by the Federal Reserve, a lot of refinancing activity into fixed-rate mortgages took place as homeowners took advantage of historically low rates. As a result, mortgage debt service payments as a percentage of disposable income are close to record lows. So, the impact of higher rates on homeowners may be lessened this time around.

Policymakers continue to work on solutions. The meeting in Jackson Hole will provide additional clarity regarding interest rate policy. Meanwhile, lawmakers sprung into action and passed the Inflation Reduction Act, which was signed into law by President Biden last week. The bill spends just under $400 billion on clean energy and climate resilience, in addition to reducing some drug prices, temporarily subsidizing costs of health insurance on exchanges, and raising some taxes to offset the spending. All in all, over the next decade this law increases spending by $490 billion while raising $760 billion in revenue, thereby reducing the federal deficit by about $270 billion, making it the largest deficit reduction bill since 2011. However, despite the name, the bill will not have a significant impact on inflation in the near term. The most direct impact on inflation is via provisions to lower prescription drug costs for Medicare beneficiaries, thereby decreasing federal government spending.

Nevertheless, the bill is still significant with respect to climate and the energy transition. For one thing, it is an “all-of-the-above approach” that includes tax credits and subsidies for both alternative sources as well as oil, gas, and nuclear. The credits and subsidies are meant to incentivize adoption of clean energy, instead of using punitive measures to reduce demand for traditional fossil fuels. The law also seeks to revive industrial activity in the U.S., with incentives such as tax credits for in-shoring. For example: Electric vehicle tax credits apply only to cars made by companies that relocate supply chains out of China and other countries with which the U.S. does not have a free-trade agreement. The credits include requirements for cars to be assembled in North America while using critical minerals and components sourced domestically. This is a major shift with respect to the U.S. government’s role in industrial development and a counter to similar roles played by countries such as China, which seek to promote their own high-tech sectors.

Our assessment of the U.S. economy acknowledges some risks are worth watching. Housing and interest rates are concerns but are likely not as impactful as in previous market declines. Policy changes, whether rates or bills, which are designed to fight inflation, seem likely to have the biggest effect. The Inflation Reduction Act has received a lot of press, but is predicted to have little to no impact on inflation. The biggest inflation and market impact this week is likely to come out of the monetary policy conference in Jackson Hole, Wyoming, not Washington, D.C.

Tax Breaks and Rebates

The Inflation Reduction Act of 2022, which was recently signed into law, offers some financial incentives for households and businesses that are ready to begin transitioning to cleaner energy. Here are a few of the key tax breaks and rebates for individuals.

• $7,500 tax credit for a new electric vehicle (EV). Anyone who purchases an electric, plug-in hybrid, or hydrogen fuel cell vehicle between now and 2032 may qualify for up to $7,500 in tax credits. Americans who purchase used EVs may qualify to receive up to $4,000 in tax credits or 30 percent of the sale price, whichever is less, reported Greg Lacurci of CNBC. Next year, car buyers will be able to choose whether to take the tax credit as a discount at the point of purchase, reported Kelley R. Taylor of Kiplinger. These credits could give the EV market a boost if consumers who were deterred by the higher cost of electric vehicles, reconsider the option.

The latest generation of mainstream EVs typically cost less to own than similar gas-powered vehicles, a new development in the automotive marketplace with serious potential consumer benefits.

Consumer Reports

• Tax credit for solar panels and other renewable energy sources. There is also a tax credit available for consumers who install solar panels or other equipment designed to capture and store renewable energy from wind, geothermal, and biomass fuel, reported CNBC. The credit extends and enhances an existing program. Under the current rules, homeowners who complete clean energy projects may qualify for a tax credit of up to 30 percent of the cost if the project is done before 2032. The credit falls to 26 percent in 2033, and 22 percent in 2034.
• $2,000 annual tax credit for improving home energy efficiency. From 2022 through 2032, homeowners may receive a tax credit for installing energy-efficient windows, skylights, water heaters, and doors, as well as electric or natural gas heat pumps, and biomass stoves or boilers.

The legislation also includes rebate programs, which will be administered by state governments, for consumers who cut home energy use by at least 20 percent.

The IRS Backlog Continues

As of May 31st, The IRS was still sitting on 21.3 million unprocessed tax returns. This continuous growing backlog has left many taxpayers waiting at least 10 months for their refunds from their returns. According to the Taxpayer Advocate Service, the primary reason for this backlog is that about 17 million taxpayers filed paper returns, and added that the agency is almost finished processing 2021 tax returns. The IRS announced in March their plan to hire 5,000 new employees, but as of May they had hired less than half of their goal.

Did you Know? This Week in History

August 25, 1939: “The Wizard of Oz” Opens in U.S. Theaters

On August 25, 1939, The Wizard of Oz, which became one of the best-loved movies in history, opened for the first time in theaters.

Based on the 1900 children’s novel The Wonderful Wizard of Oz, by L. Frank Baum (1856-1919), the film starred Judy Garland as the young Kansas farm girl Dorothy, who, after being knocked unconscious in a tornado, dreams about following a yellow brick road, alongside her dog Toto, to the Emerald City to meet the Wizard of Oz. Along the way, Dorothy encounters a cast of characters, including the Scarecrow, the Tin Man, the Cowardly Lion and the Wicked Witch of the West.

The Wizard of Oz was a modest box-office success when it was first released, but its popularity continued to grow after it was televised for the first time in 1956. Although the scenes in Kansas were shot in black and white, The Wizard of Oz appeared in vivid Technicolor, which was a new film process at the time. Today, some of the film’s famous lines, including “There’s no place like home” and “Toto, I’ve a feeling we’re not in Kansas anymore” are well-known to several generations of moviegoers.

The Wizard of Oz was one of the first 25 films to be put on the National Film Registry, which is reserved for culturally or historically significant movies.

Weekly Focus

If life were predictable it would cease to be life, and be without flavor.

Eleanor Roosevelt, Former First Lady of the United States

Spread love wherever you go. Let no one ever come to you without leaving happier.

Mother Teresa, Roman Catholic Nun